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MenuWhat are the most important pros and cons of raising funds via equity or convertible debt?
In considering which structure to use for a seed round, what are the most important pros and cons of Equity and Convertible debt, as they relate to each other? Delaying valuation is an obvious one, but what other points should be considered in doing a compare and contrast?
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I have raised money for companies ranging from startups to Fortune 500 companies, as a founder, an independent director and as an agent. The main salient difference is not so much deferring valuation (unless you give the convertible buyers a ratchet) as it is the trade off of who gets what in the case of huge success on the one hand or utter catastrophe on the other. In the case of huge success, its better to sell less equity so the convertible is probably the way to go. In the case of utter catastrophe you dont want a fight over who gets the desks and pencils, so in that case its better to have sold equity. Its all pretty much no more complicated than the calculus of greed on the part of the founders. Good corporate finance practice formerly dictated that issuers only sell debt if they have cash flow to service it, as few startups do. If you would like to discuss this further, let me know.
I would consider convertible equity (not debt) for smaller / Seed rounds. They're generally simple and efficient.
If you decide on convertible, I would use something like 500 Startups' KISS docs: http://500.co/kiss/
See more info here: http://venturehacks.com/articles/debt-or-equity
The terms of each deal are important when making this comparison. The biggest difference you should consider is the convertible debt option will most likely put you personally in a position to guarantee the debt. The company could also be strapped with cash obligations if the terms call for payments of interest or principal in the short term. You have to evaluate your Company's burn rate, the terms of each deal and compare on compare in a comprehensive manner. I have had experience with many term sheets. Feel free to reach out to me if you would like to set up a time to talk.
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As a startup, is it better to find a way to pay for services (i.e. design) or trade equity for it?
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